US equity markets continue to fall and have now erased the March rebound, breaking through to new lows.
The S&P 500 fell 3.3% last week and is now down 12.9% for the calendar year to date. The NASDAQ was off 3.9% and has lost 21% for the year.
The S&P/ASX 300 continues to display more resilience — down 0.8% for the week but still up 1.2% for the year. It has now reversed almost all its underperformance of the US market since the start of the pandemic.
The expected hit to resources occurred on Tuesday, but hope of Chinese stimulus led to much of that unwinding through the week.
Four issues are weighing on markets:
While some economic data released last week looks a bit soft, it is unlikely to change the Fed’s current course of back-to-back 50bp rate hikes.
There was some improvement in sentiment on China following comments from President Xi around supporting growth via stimulus.
We saw Russia turn off gas supply to Bulgaria and Poland, raising concerns over an escalation. There was some speculation over the weekend that the EU may start refusing Russian oil in May.
An ugly inflation print in Australia means this month’s RBA meeting is now “live” in terms of a rate hike.
A 2% drop in the Australian dollar as the US dollar continues to rise adds to the RBA’s conundrum regarding inflation.
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There are signs of stress building in markets. But we are also seeing weak sentiment and some pockets that look to be oversold.
This is a critical juncture in terms of which way markets break. We remain cautious in the near term.
Key areas of concern include:
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At a headline level the season looks good so far (about 55% of the market has reported).
Aggregate earnings per share (eps) for the year are up 9% versus an expected 5%. There are more beats than usual.
However a lot of the momentum is driven by the energy sector. Stripping it out, eps growth falls to 3%, which is a material deceleration.
The market was hoping decent earnings from Meta, Apple and Microsoft would improve sentiment towards technology — but it was not enough to hold the sector up.
Amazon disappointed after logistic and fuel costs were US$2 billion higher than expected. It wore also US$4 billion of internal costs relating to sub-optimal staff issues and excess capacity in fulfilment.
While Amazon sees no signs of a slow-down in consumer demand, it could still come later in the year.
This result highlights the emphasis that will now be placed on cost. This may be the first warning sign of a weaker labour market.
The other issue to watch is that Amazon alone represents 10-11% of total US private non-residential construction activity, and that share has doubled since 2015. They also represent 25% of US warehouse construction. So clearly any signs of slower capex spending may also affect other sectors.
Buy-backs will start to kick again soon which should support the market.
Concerns over Chinese growth continue to mount. However last week we saw more confidence in the policy response from Beijing.
The Politburo’s April 29 meeting emphasised keeping the epidemic contained and the economy on track.
These twin goals are clearly contradictory — but the message is China will strive for its growth target.
This may indicate they would accept falling short, given the extenuating circumstances. But it also suggests they will take action to try to get close, which likely means substantial infrastructure stimulus.
Chinese stocks and resources stocks performed well in response.
Beijing is facing a myriad of issues: the effect of lockdowns on consumer demand, supply chain disruption, a weak housing market, high household debt, slowing global growth and a currency appreciating against competitors.
The question is whether policy measures will be effective in dealing with these issues.
Projects have lagged, there are constraints on labour and materials and cost inflation is high. There is a risk the infrastructure lever won’t work this time.
Russia turned off the gas to Bulgaria and Poland raising the risk of more broad-based disruption.
The move looks carefully considered as a signal. Both countries only import small amounts and have alternative sources of supply, so the economic impact is likely to be limited. It does demonstrate that the risks to supply disruption are higher than the market is pricing.
There is speculation the Europeans may begin to restrict Russian oil imports, having found some alternative sources.
This would probably underpin oil prices if it occurs, which have been under pressure from Chinese lockdowns.
Last week we saw:
This is expected to lead to faster and earlier rate moves in Australia.
Two-year rates are now expected to hit 3%, which is among the highest in developed nations. This is surprising given the degree of household debt and variable mortgages.
This highlights the challenge that the economy needs to be slowed quickly. If rates don’t get high it will only be because the economy is weak.
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
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